Archive for the ‘Fiduciary Issues’ Category

Risk questionnaires have played a major role in retirement and investment planning for as long as I can remember; and I’ve used them no less religiously than any other advisor. Frankly, I’ve always felt they were a little stupid.

Elmer Duckhunter walks into Brainy Smartsuit’s office at Behemoth Securities. It’s a beautiful place, full of mahogany with lots of beautiful brochures in the lobby. Brainy has been successful at Behemoth, gaining promotion to Sr. Vice President after selling more Secure Your Future product than anyone else in the office using the “Secret in a Box” software supplied by the product wholesaler.

“How can I help you?”, Brainy asks.

“Well,” says Elmer, “I have a lot of money from all those Tractor Pulls I won and I think it’s time I began investing for my future. What should I invest in?”

“I think I can help you, but first I have to know more about you!”

“Makes sense. What do you want to know?”

Brainy pulls out the Behemoth Risk Assessment questionnaire. “First, I’d like to know a little about how you feel about investing.”

“Okay.” Elmer settles in. “How many questions are there?”

Brainy smiles, “Just six.”

“Six? You can learn everything you need to know about me with just six questions?”

“Trust me. This is very scientific, “says Brainy.

“Okay.”

Brainy begins. “On a scale of zero to 10, how much risk do you feel you can handle?”

“I don’t know. What would a ‘five’ feel like?”, asks Elmer.

“Just pick one that you feel comfortable with, says Brainy. “The people who prepare these know what they’re doing.”

Elmer thinks for a second. “Well, back in 2007 I was a 9, but after the crash I was a 2. Now, I don’t know what I am. That’s why I’m here!”

“Well, I can’t tell you how much risk to take until you tell me how much risk you want; then, I can tell you what you told me and we’ll have the answer!”

“Huh?”

They both look at each other, then Elmer continues, “How much risk do I want? Seems to me you should be telling me how much risk I need or don’t need!”

“But what if it’s more than you want?”, asks Brainy.

“I don’t know how much I want. I need to know how much I should or should not have?

Brainy perks up. “Now we’re getting somewhere. What are your goals?”

“Simple”, says Elmer, “to retire with as much money as possible with as little risk as necessary.”

“How much is that?”

“How should I know? You tell me.”

Brainy senses a lack of forward progress. “Let’s come back to that. Try this one: If your portfolio went down, what would you do?”

“I’d probably ask you for advice! Isn’t that your job?” Elmer’s beginning to wonder if Brainy Smartsuit is so smart after all. “Why are you asking me all this. I just want to know what I should be doing!”

Brainy comes clean. “We have regulatory compliance concerns. We have to make sure what we recommend is consistent with how you feel about investing.”

“I’d rather have advice that’s consistent with what I need,” says Elmer. Are you protecting me or your firm?

“Well, actually, both…”

“There are six of these?” Elmer’s fed up. He puts on his duck hunter cap with earflaps, and stomps out of the office.

Maybe these questionnaires can shed some light about attitudes; but, they don’t tell Elmer what he needs to know. Elmer just wants to know what he should be doing and why.

Once he understands what and why, the rest gets easier. Fear can exist only where there’s a knowledge vacuum. When knowledge replaces ignorance, fear dissipates and understanding prevails.

Maybe questionnaires have zero to do with long term success for the client; but, they maybe do help sell more Secure Your Future product.

Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting and wealth management services for individual investors. Opinions expressed are solely those of the author and fictitious names were created solely for their entertainment value and are not meant to represent any person or organization living or dead. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. IFG also does not provide tax or legal advice. The reader should seek competent counsel to address those issues. Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan. The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com

It doesn’t matter what an advisor’s business model is, each has its own built-in bias. And, let’s face it, it’s probably true of every business model in any business. It doesn’t mean the advisor isn’t honest or does quality work, it’s just good that you know that bias always exists.

Here’s the bias of the four primary business models.

Commission: The bias may favor products that pay higher commissions.

Hourly fees: The bias may favor stretching-out the work to increase income.

Asset-based fees: The bias may favor advice given on existing assets to maintain higher asset levels.

Flat retainer fees: The bias may favor doing less work – reduced incentive to work longer

The bottom-line: The advisor, like any other professional, must be someone you trust to be acting in your best interest. After all, the form of compensation doesn’t necessarily dictate ethics standards.

Regardless of the compensation, I would simply ask if the advisor is willing to put in writing that s/he will actually accept fiduciary status in ALL his/her dealings with you, both in the planning stage and in the implementation stage.

If the standard is ‘suitability’, the advisor has wide latitude as long as the investments are ‘suitable’. If the standard is ‘fiduciary’, the advisor MUST act in YOUR best interests. The standard they’re willing to accept – in writing – can tell you a lot.

And, that may tell you all you need to know.

Jim Lorenzen, CFP®, AIF®

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Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

The recent decision in Tussey v. ABB, the first full trial to consider whether fees in a large 401(k) plan were excessive, the defendants, ABB and Fidelity, were on the losing end and ordered to pay $36.9 million in damages.

I’m not an attorney; nor do I play one on t.v.; but, I’d say this sounds ominous. Even so, the fiduciary duties of loyalty, prudence, and disclosure are not difficult to fulfill. It’s certainly easier than spending time and money defending a lawsuit – something we’ll likely see more and more of as participants see the disclosures and learn, probably online, how to compare their plan to others out there.

Not only is there an increase in activism fueled in social media; but, increasingly, tools are becoming available that anyone can access. Unfortunately, most employees participating in 401(k) plans simply do not have the educational background to utilize their plans wisely. According to the Society of Actuaries’ 2011 Risks and Process of Retirement Survey (p.3), Americans’ financial literacy leaves much to be desired: “… inadequate math skills, their poor understanding of financial concepts such as compound interest, and their lack of basic comprehension of the functioning of investment markets.”

The same survey revealed that just one-third of pre-retirees (35%) say they have a plan for financing their retirement.

At a minimum, employees appear to need a wake-up call; and, given the average participant’s well-documented ineffective use of the 401(k) plan, you’d think that fiduciaries, acting as ‘prudent experts’ would be providing employees a personalized gap analysis; but, it appears most aren’t even doing this, despite the fact they know that few feel they’ll be financially prepared for retirement.

Most plan sponsors seem to cite retirement benefits cost and regulatory complexity as impediments, which seems to indicate that what’s important to them conflicts with their fiduciary duties… a dynamic which some regulators might arguably view a self-dealing, i.e., a prohibited transaction.

When fiduciaries can’t document what they did and their rationale for doing it, this absence of a paper trail can provide strong evidence that they didn’t fulfill their duty of loyalty (exclusive benefit rule) or behave prudently.

They’re worth reviewing:

Exclusive Benefit Rule – The fiduciary “must discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of: (i) providing benefits… and (ii) defraying reasonable expenses of administering the plan.” [29 U.S.C. §1104(a)(1)(A)

Prudent Man Rule – A fiduciary must act “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would…” [29 U.S.C. §1104(a)(1)(B)]

Those treating vendor paperwork as oversight have a right to question it’s objectivity and potential conflicts.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here. Opinions expressed are those of the author. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Few retirement plan fiduciaries can document that they are monitoring their providers or whether their decisions are delivering value to help participants help themselves.

We live in an age when everyone is online and information is easy to access. Remember what happened to Bank of America when they tried to raise their fees? When plan participants begin receiving disclosures, they’ll – as well as attorneys looking for clients – will begin looking around, and the questions will begin:

“Why are we paying so much in fees? I saw on Vanguard’s website that their average expense ratio is 0.21% and that the industry average is 1.15%. I’ve I’d been in Vanguard, I’d been able to keep 93% of my investment returns while non-Vanguard investors keep, on average, just 67% of their returns!” [Source: Vanguard website ad, April 3, 2012].

Disgruntled participants will have no trouble obtaining Brightscope’s website, allowing them to compare their plan to others. They’ll be able to see the ratings difference not only in dollars and cents, but in terms of how much longer they’ll have to work! For many, a 7-point difference could amount to 5 additional years of work and over $100,000 of lost retirement income!

How many plan sponsors will be able to demonstrate why they made their choice of recordkeepers and investment options? If employees learn the top executives received an allowance for financial planning, they’ll feel even worse if the same executives didn’t feel these employees didn’t deserve receiving a periodic gap analysis to measure their progress towards achieving their retirement goals.

It’s a shame, too. Too many plan sponsors have been so used to cutting corners for so long, they don’t even realize there are easier solutions available – often less expensive and with far fewer headaches.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

If you’re participating in a 401(k) plan, it won’t be long before you’ll be seeing brand new fee disclosures on your statements; and, if you’re one of those who thought your plan was ‘free’, be prepared for a big surprise. As you may have guessed, there isn’t now, and has never been, a free lunch.

Employers will be obtaining new disclosures from all covered service providers (CSPs) and will be required under ERISA 404(a)(5) to make clear and useful disclosures to participants.

Whether your plan’s fees and expenses are too high is a relative question. The requirement for determining `reasonableness’ is mandated under ERISA (the Employee Retirement Income and Security Act). Employers are required to periodically compare their current plans with what else is available in the marketplace, given the size of the plan, number of participants, and the number and level of services the plan is receiving. There are two ways of doing that.

One way is to conduct a provider search request-for-proposal (RFP) process. The only problem, of course, is that the process can take about 4-8 weeks and can be a little costly. Despite this, it’s a process that probably should be conducted at least every three years. If your plan hasn’t conducted at RFP in the last three years, it’s more than likely your plan can, and should be, made better.

Another way is to conduct a fee and expense benchmarking process. This is less expensive and something all plans should probably do annually. It’s simply a process of comparing your plans to others of like size, etc. Two things to keep in mind about benchmarking: (1) it’s best if the study can reveal what comparable plans – roughly same size, number of participants, etc. – are actually paying, not a bidding process, and (2) what’s `customary’ may or may not be `reasonable.’

What You May Not Know

If your plan is comprised of funds from a few fund families, you might want to take a look in your funds’ prospectuses. Look to see if there are 12b-1, shareholder servicing, and sub-transfer agent fees (Sub-TA fees). If so, it’s possible these fees are there to pay plan expenses that otherwise would be billed directly to the plan under `revenue sharing’ arrangements between service providers.

These may not be unreasonable; but, I’ve always felt that transparency leads to greater competition and, therefore, lower prices. I’ve never understood how hidden fees can be good; nevertheless, they do exist. But, one has to wonder what the incentive would be to replace a high-fee fund that pays revenue sharing to the plan vendor with one that has no such fees and pays no revenue sharing. How much would service providers charge then, if they had to use fully-disclosed billing? Oh, well, that’s just me.

If your plan is one using an `open architecture’ platform – you can select from hundreds of funds and families, including no-load and index funds that don’t pay revenue sharing – consider yourself one of the lucky ones. Just be sure you’re getting the education you need to make prudent decisions. Remember, the best investment process isn’t exciting, entertaining, or even worth discussing with your friends. The best process is often boring, but effective.

You don’t have to be brilliant. All you have to do is be smart – and that’s the same thing as not being dumb.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Everyone hates report cards; but, without them, we’d never know how we stand against expected standards of conduct.

When it comes to a corporate retirement plan sponsor’s fiduciary responsibilities, failure to know where one stands can result in serious consequences.

How do you know when your plan structure is ‘best-in-class’? Northern Trust in their October 2010 study identified “Characteristics of Ideal Plan Structure”. Their findings cab help plan sponsors identify and remove headaches before they begin.

A true fiduciary MUST act SOLELY in the best interest of plan participants and for the EXCLUSIVE purpose of providing retirement plan benefits. I’ve capitalized the key words for a reason: They’re critical… and they apply to plan sponsors who make decisions on their company plans… they also affect anyone else doing the same thing.

Recognizing the difference between a true fiduciary advisor and a vendor rep is key. Patrick C. Burke, Managing Principal of Burke Group, a retirement, actuarial and compensation consulting firm in New York stated in a recent interview for Fiduciary News, “Bundled providers’, brokers’, and financial intermediaries’ operating models cannot be considered best-in-class due to their inherent and unsolvable conflict. This would include any RIA who participates in a revenue sharing or 12b-1 compensation package. They are primarily in the investment business which excludes their ability to be conflict free, a basic requirement of any plan sponsor that desires to achieve best in class status. These firms are the classic example of a fox in sheep’s clothing.”

Think 12b-1 fees and revenue sharing are unimportant? You need only follow the money. If providers are being paid from the revenue sharing of those 12b-1 fees, what are the chances a fund paying revenue sharing will be replaced with a low-cost, true no-load fund that charges no 12b-1 fees or pays revenue sharing? Unfortunately, far too few plan sponsors are even aware of this issue’s seriousness or the extent of their personal liability.

I even heard one exclaim, “I’ll take my chances.” I once heard another say, “Our advisor isn’t a fiduciary on the plan…”, as if this was a good thing.

Still another once said to me, “We provide a huge selection of funds…”, and in the same breath said, “we don’t worry about providing investment education.”

Does that sound like a fiduciary to you? If a vendor doesn’t want to take fiduciary status, the question has to be, ‘Why not?’

Back to planet earth.

Burke, among many other true fiduciary advisors advises plan sponsors to have a Fiduciary Report Card completed by an independent, outside, non-conflicted plan consultant. This approach helps plan sponsors focus on “best in breed” service providers and also helps create evidence of a true fiduciary process.

If you haven’t addressed these issues in the past twelve months, this might be the time to do it. Those who are depending on their retail vendor-driven providers for new disclosures might find themselves scrambling to play catch-up later.

You may want to contact an ERISA attorney and an independent plan consultant. I’m not an ERISA attorney; but, I think I might know a plan consultant…. if I can just think of his name……

Jim

Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Retirement plan participants will soon find out how much they’re really paying for their retirement plan; but, there’s more to the story.

While I have faith that many service providers will go to great lengths to find a way to make the disclosures confusing – there is a lot of money at stake – some will be more transparent. Either way, it won’t be long before word gets out on what to look for; after all, people do talk to each other and it won’t be long before someone gets it.

Here’s an oversimplified but excellent example:

There are three basic functions to running a retirement plan. In no particular order, they are:

Investment advisory and management – The advisor to the plan and the investment managers, in most cases mutual fund companies.

Often, usually in ‘bundled’ solutions, all three are paid from a bundled fee to a package provider based on assets under management in the plan. Why a package provider – and the additional compensation required for them – is necessary, I haven’t figured out yet.

I can understand any entity having an impact on investment (and investor) performance having compensation tied to asset value; that’s shouldn’t be a potential problem. The problem will likely come when plan participants begin thinking about – or someone tells them – about #2 and #3.

Recordkeeping and administration are ministerial activities. They’re administrative functions that have no impact on, or connection to, the investment, or investor’s, performance.

Think about it: If two companies each have 100 employees, it costs just as much to file a form or credit a deposit for a participant in a $3M plan as it does in a $15M plan. Why should the $15M plan pay five times as much for the same service?

How about two participants in the same plan? It wouldn’t be surprising to find them comparing statements only to find out that one is paying twice as much as another for the same administrative function – one that has nothing to do with their investments.

That’s when they’ll start knocking on the door of the CFO or the HR director asking, “Why am I paying twice what she is simply to process a withdrawal?”

Hamina, hamina, hamina…..

“…. and I have another question…..”

Plan sponsor fiduciaries will have to be ready with the right answers.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.